Court of Final Appeal delivers landmark decision on keepwell deeds: Breach of liquidity obligation did not cause any loss to the insolvent issuers and guarantors

Keepwell deeds have commonly been used by Chinese parent companies to provide their offshore subsidiaries with financial backing for their bond issuances.  They gained popularity as a means to address Mainland law restrictions on the provision of guarantees to offshore entities (although such restrictions have since been relaxed, subject to obtaining regulatory approvals).  By using keepwell deeds, parent companies promise to keep their offshore subsidiaries solvent and have sufficient liquidity to meet interest and principal payments on their bonds.

On 19 March 2025, the Hong Kong Court of Final Appeal ("CFA") delivered a landmark decision regarding keepwell deeds in the long-running case involving Peking University Founder Group Company Limited ("PUFG").  The CFA clarified the correct interpretation of PUFG's liquidity obligation and provided guidance on how losses arising from a breach of this obligation should be assessed.

Background

PUFG, a Mainland company, issued over US$1.7 billion in bonds through its offshore subsidiaries in 2017 and 2018.  The bonds were guaranteed by two other offshore subsidiaries.  The offshore subsidiaries defaulted, and PUFG has been under reorganisation since 2020 by order of a Beijing Court.  The offshore subsidiaries claimed losses against PUFG for allegedly breaching the keepwell deeds that formed part of the bond issue documentation.  The deeds required PUFG to maintain at all times a positive consolidated net worth of at least US$1.00 for all four subsidiaries ("Balance Sheet Obligation"), ensure sufficient liquidity to meet bond payments ("Liquidity Obligation"), and undertake to use "best efforts" to obtain regulatory approvals to the extent they are needed to perform obligations under the deeds ("Relevant Approvals").

The Court of First Instance ("CFI") gave a declaration that PUFG breached the keepwell deed for one subsidiary by failing to meet the Balance Sheet Obligation, resulting in a liability of RMB1,154,012,000, the amount the subsidiary should have received from PUFG but did not.  The CFI dismissed claims by the other three subsidiaries, as the alleged breaches occurred after PUFG entered reorganisation proceedings.  Once PUFG was in reorganisation, the CFI found that there was no realistic likelihood of Relevant Approvals being granted and, therefore, no breach of the "best efforts" undertaking.  See our previous blog post and [2023] HKCFI 1350.

The Court of Appeal ("CA") overturned this and gave a declaration that PUFG breached the keepwell deeds in respect of the three other subsidiaries by failing to meet the Liquidity Obligation, resulting in a liability of approximately US$1.7 billion, the amounts payable by them under the bonds.  The CA found that the CFI had failed to consider the evidence on alternative modes of performance of the Liquidity Obligation that did not require Relevant Approvals, such as using offshore assets, or financial support from third parties not restricted by PRC law.  If no Relevant Approvals were required, the alleged difficulties of obtaining Relevant Approvals and whether PUFG used its "best efforts" were therefore irrelevant.  See [2024] HKCA 445.

Discussion

PUFG appealed to the CFA arguing that the failure to provide liquidity to the offshore subsidiaries, in breach of the Liquidity Obligation, did not cause the offshore subsidiaries any loss.  The CFA unanimously allowed the appeal, finding that the offshore subsidiaries had suffered "no net loss" of their own.  Rather, the true loss was suffered by the bondholders.  The CFA varied the Court of Appeal's declarations accordingly, holding that PUFG was only liable to pay nominal damages to the offshore subsidiaries for failing to meet the Liquidity Obligation.

The key legal principles discussed were as follows:

• Use of loans to satisfy liquidity shortfalls – Although the keepwell deeds did not specify how or in what manner sufficient funds were to be made available to the offshore subsidiaries, the CFA found that the keepwell deeds clearly contemplated the use of loans as a permissible mode of compliance. This was because in another section dealing with events of default, the deed required PUFG to provide a lending facility for the offshore subsidiaries to satisfy their payment obligations.  Contrary to the offshore subsidiaries' argument, PUFG was not required to fulfil its Liquidity Obligation by means other than lending, such as by making a gift.

• Foundational rule of damages – The starting point is that damages for a breach of contract is compensatory and based on placing the plaintiff in the position it would have been in had the contract been performed.  In this case, the consequence of PUFG's breach of the Liquidity Obligation (i.e. by failing to lend money) should be assessed by considering the position each offshore subsidiary would have been in if PUFG had fulfilled the Liquidity Obligation.

• "No net loss" – Had a loan been provided by PUFG to the offshore subsidiaries, PUFG contended that their balance sheets would not be affected at all.  This is because the offshore subsidiaries would simply be replacing their existing liability to repay the bondholders with a new, equivalent liability to repay PUFG.  PUFG contended, and the CFA agreed, that the offshore subsidiaries suffered no net loss for which substantial damages should be awarded.  PUFG supported its argument regarding "no net loss" with the English case of Stanford International Bank Ltd (in liquidation) v HSBC Bank Plc [2022] UKSC 34, along with precedents from five other common law jurisdictions: Australia, New Zealand, the United States, Canada and Singapore.

• Insolvency does not involve loss – The CFA held that the causing of insolvency per se, without more, does not constitute financial loss.  While the entry into winding up could lead to losses, such as the diminishment of the value of assets or the increase in the amount of liabilities, those losses were not pleaded in this case.

• Loss suffered by bondholders, not issuers – The CFA considered the commercial reality of what happened and identified who truly suffered the loss.  PUFG's failure to comply with its Liquidity Obligation did not cause loss to the offshore subsidiaries, but to the bondholders who suffered the total loss of their principal and unpaid interest (subject to any recovery in the reorganization of PUFG or in the liquidation of the offshore subsidiaries).  Further, the CFA noted that it was the bond trustee, which was a party to the keepwell deeds and has the benefit of its covenants, who has a cause of action for that loss to the bondholders (allowing the trustee to sue PUFG or prove in its reorganisation).  The CFA concluded that granting substantial damages to the offshore subsidiaries had no commercial utility, as they are merely "vehicles" and "suffered no diminishment of wealth" of their own. Indeed, if the offshore subsidiaries could obtain substantial damages, this would result in a "double claim" or "double proof", whereby both the subsidiaries and the bondholders (through their trustee) could sue for the same loss.

Comments

This is the first time the Hong Kong Courts have decided on a claim for a breach of a liquidity obligation under a keepwell deed and the resulting quantum of loss.  Although highly fact-sensitive, this case confirms that a parent company's breach of liquidity obligation under a keepwell deed, by way of failing to advance a loan, does not give rise to any actionable loss to the offshore subsidiaries due to the "no net loss" rule.  However, this does not mean that keepwell deeds have no utility as:

1. the bondholders (through their trustee) as the true victim may still sue for the actual loss caused by a breach of covenant owed by a keepwell provider to the trustee;

2. the relevant subsidiaries may still be able to sue for losses manifesting, for instance, by the insolvency causing the diminishment of the value of assets or the increase in the amount of liabilities, neither of which were pleaded in this case;

3. this decision is only concerned with the breach of the Liquidity Obligation. It does not affect the CFI's declaration that the breach of the Balance Sheet Obligation caused loss to one of the subsidiaries in the amount of RMB1,154,012,000; and

4. this decision is only concerned with the failure to comply with the Liquidity Obligation by provision of a loan.  Whether the Liquidity Obligation is required to be fulfilled by means other than the provision of a loan still depends on the circumstances of each case, including the terms of the keepwell deed itself, and that may in turn affect the assessment of quantum of loss.

For more information, please contact Jojo Fan, Managing Partner, Paul Quinn, Partner, Rachael Shek, Partner, Truman Mak, Partner, William Ku, Partner, Marcus Wong, Of Counsel, Sarah Shen, Senior Associate, Sara Troughton, Knowledge Lawyer or your usual Herbert Smith Freehills contact.